The bulls came out during 2023’s last quarter to deliver, for the most part, robust returns. However, many are approaching 2024 with an abundance of caution, especially in an election year. A “K” type of economy, which we will describe later, also gives pause for concern. There are still tremendous opportunities and sector optimism, which gives hope that valuations could continue to climb. But are those in the “distressed” and “alternative” market sectors looking at an opportunistic year?

Reviewing and analyzing historical trends and current interest rate fluctuations provide insight into 2024 economic conditions. The inflation rate is an important assumption for creating cash flow models when projecting revenue for future years. With a lower forecasted inflation rate, projected future revenue will have a lower value and may result in a lower estimate of value in different industries. Here are a few factors business leaders will need to consider, which could impact valuations this year.

Inflationary Decreases and Changing Bond Rates

The Federal Reserve continues to try and bring down inflation in hopes of avoiding the possibility of an economic recession. The Federal Open Market Committee released its long-term economic projection, indicating that private sector experts are anticipating a 2.5% inflation decrease in 2024. In 2023, the U.S. economy experienced an average inflation rate of 3.1%, and the average long-term interest rate for a 20-year Treasury Bond was 4.36%. As of January 9, 2024, the 20-year Treasury Bond interest rate was 4.33%, making the rate below the 2023 long-term average in 2023. While monitoring the daily change in the interest rate, there seems to be a steady increase currently leveling off at approximately 4.4% to 4.5%.

Corporate Tax Rates

President Biden has proposed tax rate adjustments for the fiscal year 2023 budget. According to the published budget proposal, the corporate tax rate is anticipated to increase from 21% to 28%.  The increase in the corporate tax rate will impact the weighted average cost of capital (“WACC”) and final valuation conclusions.

• For the WACC, the main impact will be the weighted average capital structure, as the required return will fluctuate with any tax rate changes. This adjustment might be minimal, but it is an important adjustment that valuation experts must monitor and properly adjust when making their estimates.
• The final valuation conclusion will significantly be impacted because valuation experts must increase the taxes in cash flow models and adjust their amortization tax benefit in determining the total net present value. With a higher tax rate, the final valuation conclusion will have a lower value.

Risk-Free Versus Risk-Generated Returns

The risk-free rate is “the minimum return that an investor would accept for an investment that is virtually “risk free,” meaning it is the pure cost of money plus the rate of inflation anticipated.”  The rate hasn’t been this high in more than a decade. Currently, it is in the neighborhood of 4% to 5%.  Typically, valuation professionals often refer to the U.S. Treasury securities for determining the risk-free rates as these securities are as close as possible to a risk-free investment.

The risk-free rate is an important variable for determining the cost of equity and the WACC. Monitoring the risk-free rate is important for valuation professionals and corporations as theoretically lower risk-free rates equate to lower cost of equity. When an entity has a lower cost of equity, this may result in a higher valuation conclusion. Entities with a lower cost of equity or WACC are viewed as having less risk associated with the cash it plans to generate in the future.

Investors will be looking for better returns (i.e., higher valuations throughout the capital stack/structure). For those sitting in the C-suite, they will have to articulate their strategy for success to informed, yet arguably cynical investors. Can these leaders deliver back-to-back successful years?

Industries to Watch in 2024

Industry research provider IBISWorld, in its 2024 Global Biggest Industries by Revenue publication, lists some of the top industries business leaders need to keep an eye on from a global perspective. These include the wireless telecommunications carriers, oil and gas exploration and production, and life and health insurance carriers.

Global Wireless Telecommunication Carriers

Phones are indispensable. The demand for telecom services continues to rise, which makes the industry quite dynamic due to several technological competitors on a global scale. Though, in today’s world, that may be a significant understatement.

This industry continues to carry out the legacy of Steven Jobs, Apple Inc.’s founder, who somebody once described as a visionary who knew what people wanted before they knew they wanted it. That means a reliable, high-speed network is imperative to utilize mobile capabilities.

Telecommunications operators have primarily adopted two growth strategies (1) increasing the number of subscribers; and (2) boosting the average revenue per user. The expected revenue growth rate over the next few years will be driven by the continued worldwide rollout of 5G networks along with providing new connectivity for wearables, vehicles, and other applications.

Global Oil and Gas Exploration and Production

An increase of environmental conservation is leading to a shift from fossil fuels to renewable energy sources. Because of the rising shift, oil and gas corporations are trying to adopt more sustainable practices to ensure their relevance in the energy sector. The oil and gas industry is persistently looking for new innovations to continue exploring alternative methods that promote environmental conservation such as:

• Advanced hydraulic fracturing and enhanced oil recovery methods:
  
  • Hydraulic fracturing (aka fracking) has enhanced both efficiency and sustainability. Innovative technological processes help lower the environmental impact and boost oil recovery rates.
  • Enhanced oil recovery, such as thermal, gas and/or chemical injection stimulates production from mature fields, inevitably decreasing the environmental footprint and reducing the amount of drilling required.

• Advanced safety measures and conservationism practices:
  
  • Modern technology has prompted increased safety measures in the oil and gas industry. Real-time monitoring and drones help identify equipment issues and provide an extra set of eyes for constant monitoring in hard-to-reach places, helping prevent accidents or injuries.
  • Carbon capture storage technology assists in combatting global warming by storing carbon emissions underground.

Global Life and Health Insurance Carriers

As costs continue to skyrocket, the conversation of universal health care has become a polarizing topic in American politics. One new norm consistent in the health care industry is consolidation. Through consolidations, both health care providers and insurers have been consolidating to increase negotiating power.    

The Impact/Emergence of a K-Type Economy

Most of us are familiar with “V” and “U” recoveries; V, a sudden dip and return, a “U” a bit slower at the bottom. But there is increasing consideration to a “K,” which suggests a growing disparity between the have and have nots. It is where the majority of our country, if not the world, doesn’t have six months of an emergency cash safety net and the majority of the wealth is concentrated in fewer individuals than ever.
 
It’s incredibly important that one stays up to date with external markets and trends impacting their work. For business leaders and professionals across the country, remaining nimble and adapting to these developments is key in offering crucial and accurate valuation statements for you or your clients.

Editor's Note: This article was written with the assistance of Robert D. Katz, CTP, CPA, MBA. Rob is a Managing Director of Eisner Advisory Group and an expert in lender relations and increasing cash flow. He is one of the founders of TMA’s most successful conferences, The Distressed Investing Conference. Rob is a member of CFA’s Education Foundation. He’s been an adjunct professor at Temple University.

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Endnotes:

1 https://www.pwc.com/us/en/services/tax/library/president-biden-fy2024-budget-renews-call-for-corporate-rate-increase.html#:~:text=Key%20business%20tax%20provisions%20in,21%25%20and%20adopting%20an%20undertaxed OR https://www.whitehouse.gov/wp-content/uploads/2023/03/budget_fy2024.pdf.
2 Ibid.
3 Understanding Business Valuation: A Practical Guide to Valuing Small to Medium-Sized Businesses, “AICPA” Gary R. Trugman.
4 https://ycharts.com/indicators/20_year_treasury_rate.
5 https://www.ibisworld.com/global/industry-trends/biggest-industries-by-revenue/.
6 I5111-GL - Global Wireless Telecommunications Carriers, “IBISWorld” Terry Faber.